April 5, 2013

New Zealand's dairy industry tightens due to drought

New Zealand's milk output in March was estimated to drop 15-20% against a year ago, and April will likely be down by at least that much due to a severe and widespread drought.

New Zealand is the world's largest dairy exporter, controlling around one-third of global trade. It has been proficient at capitalising on the boom in emerging market dairy demand. Its dairy exports were worth more than US$11.3 billion in the year ending June 2012, up from about US$4 billion for the year ending June 2003. The country, however, is in the midst of a severe and widespread drought.

On February 27, the government declared the Northland region, at the tip of New Zealand's North Island, a drought zone. Over the next month the Ministry of Primary Industries extended that designation to the entire North Island and at least two districts on the South Island, and little relief is in sight.

Conditions are having a devastating effect on New Zealand's pasture-based milk production system. The final third of New Zealand's June-May milk production year will likely wipe out the first eight months of steady milk output gains, and at least one analyst foresees a 12-month decline of 2%.

Fonterra Co-operative Group, which controls around 90% of New Zealand's milk supply, said last week that it might need to ration its milk powder if the situation does not improve. The drought was already making global dairy buyers jittery, as evidenced by recent gains in international prices. Spot Oceania whole milk powder prices were up nearly 50% from the start of February, when the drought really began to bite. Skim milk powder was up 18% and cheddar up 9%.

When the dominant supplier from the world's largest exporter starts talking about possibly having to allocate to select customers, chances are that further price hikes are in the offing, particularly when you factor in New Zealand neighbour Australia, the world's fourth largest exporter. Australian milk production declined 5.6% in January and February, as it dealt with its own mix of extreme weather: scorching drought in some areas and flooding rains in others.

For both nations, most current production was booked and little excess inventory was available for the foreseeable future. In addition, EU milk production continues to trail year-ago levels.

While US farmers can certainly sympathise with destructive effects of drought, this latest development in Oceania should create opportunities for US suppliers. Historically when Oceania prices rise, they pull up US prices. As Rabobank noted in its March "Dairy Quarterly," US wholesale prices, significantly discounted in early 2013, should move up by mid-year as the global market tightens and US stocks are cleared. In addition, global dairy demand remains strong, particularly in Asia where economic prospects appear to be brightening. Customers will be looking for supply alternatives.

Conditions, in a nutshell, are lining up for potentially more business for US suppliers at a higher price point... with a few caveats. Should last year's US drought repeat in 2013, US milk supply could also be insufficient to meet demand. Should prices rise too high, it could curtail demand.

US dairy suppliers are making great strides in becoming consistent global suppliers. Dairy exports, which now represent more than 13% of annual US dairy solids, are a critical piece of the market and a key growth vector. With Oceania in a tight supply bind possibly into the third quarter, we have an enhanced opportunity in the coming months to further demonstrate US capability to serve increasingly hungry overseas dairy appetites.